The question of whether global share markets are linked or integrated has important implications for portfolio diversification and risk reduction strategies. While integration of financial markets can increase the liquidity, transparency and efficiency of markets, it can also increase the risks of contagion (Mollah et al., 2016). This paper explores the long-run and short-run relationship between the Malaysian share market and the developed share markets in Singapore, Hong Kong, the UK and the US. In this paper, the Johansen cointegration test and VAR model are used to examine the long-term relationship of the Malaysian share market with the developed markets. The results indicate that the Malaysian share market is not integrated with the above markets in the long term. However in the short-term, a one-way Granger causality exists between the Malaysian share market and the US and UK share markets. The results are consistent with the notion that developed share markets have a significant and positive influence on the short-term returns of smaller share markets such as Malaysia’s. The results also affirm the general view that price movements in developed share markets can be used as a guide for investment decisions in emerging markets.

Description

The process of globalization through financial integration has resulted in growing foreign direct investments, reduced cost of trading, increased liquidity of markets, improved transparency and market efficiency (Jeon and Chiang, 1991). Among the factors driving financial integration are improvements in technology and communication, introduction of new and innovative financial products and the deregulation and liberalization of markets (Mussa, 2000). The measures taken to liberalize share markets include removing restrictions imposed on foreign equity ownership and introduction of liberal exchange rules on listing requirements. This in turn has resulted in increased inflows of foreign portfolio investment, increase in the number of cross-listed companies and volume of shares traded. However, market integration has also seen an increase in price instability and impairment of market efficiency (Kawakatsu and Morey, 1999). While the liberalization of share markets is expected to facilitate cross-border investments, it is also expected to increase the degree of correlation between markets leading to higher price volatility and trading instability. With market integration and improved linkages, the volatility of share prices and exchange rates may also spill across national boundaries. An early study by Eun and Shim (1989) found that a significant amount of correlation exists among national share markets and that economic shocks originating from the US are transmitted to other markets. Schwert (1989) analyzed the relationship of share price volatility with macroeconomic activity, share market volume, corporate gearing, default risk, and bond yields. The data from 1957 to 1986 indicated that share market volatility increased during recessions and was correlated with financial leverage, interest rate and corporate bond yields.